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In the final part of our Fixed Income Focus we will summarise our current investment strategy and explain how it is implemented via our approved managed funds. Our preference is to use managed funds to invest in fixed income because they provide cost effective access to a wide range of securities and markets. It is extremely difficult for an investor to achieve diversification outside a fund because most markets cannot be directly accessed.
A managed fund must satisfy numerous criteria prior to being approved by our Investment Committee. Some of the things we consider are:
- the quality of the personnel
- performance track record
- the level of fees charged.
- a superior research rating from an external research consultant.
The fund’s investment approach must also align with our current investment strategy. A summary of the key aspects of this strategy are outlined below.
Preservation of capital
Fixed interest is held for defensive reasons. It should generate a reasonable return without exposing an investor’s capital to excessive risk. The temptation in a low interest rate environment is to invest in a fixed interest managed fund which is delivering an unusually high return. The investment manager is usually generating these returns by investing in higher risk securities. This strategy usually results in the investor losing more capital than the additional income which originally attracted them to the investment.
In the current environment our preference is to allocate to investment managers who implement conservative investment strategies. They would prefer to retain funds in cash rather than invest in securities which carry a higher risk of capital loss, even if this means lower returns in the short to medium term.
Investing in securities with a higher credit rating lowers the chance of capital loss. A credit rating agency assists an investor to determine which securities satisfy this criteria. The table below summarises the rating scale provide by the two of major rating agencies. The highest rating a security can achieve is AAA. The investment managers in our portfolio remain focused on the highest quality areas of the market, holding securities with an average credit rating of A to AA.
Liquidity means you are able to sell an investment at a price which reflects the underlying value of the investment. Liquidity is very important when a portfolio is required to fund pension payments or other liabilities. Higher risk securities generally have less liquidity. For example, there have been instances in the listed hybrid market where no trades have occurred for an extended period of time. We favour investment managers who pay strict attention to portfolio liquidity as part of their investment process.
Diversification is a key part of any portfolio. In the fixed income sector diversification is achieved by investing across a wide range of securities both domestically and overseas. For example, one of our investment managers invests in over 500 different securities. Whilst this may seem like a high number it is necessary given the global fixed income market is significantly larger than the global equity market.
Based on the above investment strategy our fixed interest portfolios remain focused on government bonds, semi-government bonds, high quality corporates and cash like investments. We are avoiding any material exposure to sectors which are contradictory to this strategy, including hybrid securities, high yield bonds and emerging market debt.
This concludes our focus on the fixed income sector. In the next edition of Private Wealth View we will focus on a new topic relevant to your investment portfolio.